MANUFACTURING

Made in South Africa

Taking a closer look at the importance of long-term intensification of South Africa’s industrialisation process and the movement towards a twenty-first century knowledge economy.

Local manufacturing continues to play a crucial role in terms of the vision of an equitable society as defined by our National Development Plan. The various sectors local manufacturing encompasses also create jobs for a substantial number of South Africans across the board.

The recent Industrial Policy Action Plan (IPAP) document released by the Department of Trade and Industry mention its core objectives as set out in the National Industrial Policy Framework (NIFP) of August 2007: To facilitate diversification beyond our current reliance on traditional commodities and non-tradable services. According to IPAP, this requires the promotion of increased value-addition per capita characterised particularly by movement into non-traditional tradable goods and services that are competitive in both export markets and the domestic economy.

The Plan further highlights the importance of long-term intensification of South Africa’s industrialisation process, and movement towards a twenty-first century knowledge economy; the promotion of a more labour-absorbing industrialisation path with a particular emphasis on tradable labour-intensive goods and services and economic linkages that catalyse employment creation; the promotion of a broader-based industrialisation path characterised by greater levels of participation by historically disadvantaged economic citizens and marginalised regions in the mainstream of the industrial economy; and the contribution to industrial development in Africa, with a strong emphasis on building regional productive capabilities, too.

IPAP’s central focus on manufacturing derives from a thorough analysis and understanding of its major attributes as a driver of balanced development. It is, as always, worth reiterating the benefits that a strong, well-diversified manufacturing sector bring to the economy as a whole:

The manufacturing sector has the highest economic and employment multipliers of any sector. Backward linkages in manufacturing ‘pull through’ inputs from primary and other manufacturing and services sectors and transform them into higher-value added products, stimulating employment and economic linkages along the entire value chain. At the same time manufacturing provides an added impetus to employment and growth through forward linkages to ‘downstream’ sectors, including services.

Manufacturing is central to our export strategy, based on value-added, labour-intensive tradable products that generate revenues which have both a significant positive impact on the balance of trade and impact directly on the non-exporting sub-sectors which form part of domestic value chains. It also reduces SA’s vulnerability to commodity price fluctuations/volatility and alleviating ‘Dutch disease’-type effects on the currency.

Manufacturing plays a critical and indispensable role as a driver of innovation and productivity growth. It should increasingly provide the capital goods and equipment inputs required for the infrastructure build programme, which is central to South Africa's growth strategy - while, more generally, ‘feeding’ locally manufactured inputs into public goods, including transport, health, education and housing. An enhanced role for manufacturing in providing inputs to the infrastructure programme will also be critical in reducing its dependence on imports and mitigating wider vulnerabilities, particularly on the balance of trade.

The growth and strengthening of the manufacturing sector both requires and is a driver of more energy-efficient, less carbon-intensive growth. Greener manufacturing has a great potential contribution to make in limiting wasteful resource consumption and mitigating the environmental impact of economic development.

The manufacturing sector generates among the strongest forward and backward linkages across the economy, which are important transmission mechanisms for growth and poverty reduction. This underscores the crucial role manufacturing has in driving growth and employment levels. On the demand side, these linkages create indirect and induced jobs; on the supply side, the linkages come from knowledge and technological spillover effects. Service inputs such as logistics, financial services, ICT, advertising, research and development, office support staff and so forth supports the manufacturing sector. The manufacturing-related services sector also tends to operate in much closer proximity to new technological frontiers, with innovation a key factor in driving both fresh demand and productivity gains across the entire manufacturing landscape.

IPAP states that the global economy has begun to emerge, tentatively and unevenly across countries and economic zones, from the Great Recession precipitated by the financial crisis of 2008. There will, by many accounts, be no quick return to sustained and strong growth in the global economy, while world output is predicted to remain muted over the medium term according to the report.

This includes slow growth and less demand in South Africa's traditional trading partners, the Eurozone, the UK and the US. [The Eurozone averaging a barely positive 0.1% over quarters 1-3 of 2013 both the UK and the US averaging just 1.9% growth over all four quarters of 2013 (the UK up from 0.3% in 2012); the US down from 2.8% in 2012, though showing some recovery - to 3.2% - in 2013].

The Great Recession has both revealed and intensified emerging structural changes and shifts in the balance of economic growth and power in the global economy as per the document. Developing economies are predicted to continue to grow at a significantly faster rate than the developed economies, though that growth will be relatively muted (compared with pre-2008 levels) precisely because of the persistence of depressed demand in the economies of the North.

Developing countries are thus of necessity increasingly focussing on expanded domestic demand and rapid structural change up the value chain.

The IPAP document also mentions a ‘new pattern’ of global growth is emerging, which places South Africa, along with other emerging economies, in a situation where it must seek to maintain its trade with its traditional trading partners while simultaneously building stronger trade links and enhanced export performance in relation to other emerging economies of the South.

What this tells us, from a policy point of view, is that it is essential that we build sectors and companies that can compete against imports in the domestic economy and more effectively penetrate international export markets.

The IPAP document also points out that South Africa achieved reasonably high growth rates during the 2005-2007 period. But even in this period its growth trajectory was (and remains) encumbered by structural imbalances. Pre-dating the onset of the recession – and despite the fact that South Africa did not experience a significant commodity boom – the domestic economy has continued to attract massive short-term capital inflows into domestic resource and equity shares and the bond market as a direct result of high real interest rates relative to other developing countries. This contributed to preventing the exchange rate from playing its role as a stabiliser of the productive sectors of the economy. Latterly, while the exchange rate has weakened significantly, ongoing currency volatility remains a serious problem, the report indicates.

At the same time, SA’s exports remain predominantly commodity-based, while the country’s ‘export basket’ continues on the whole to be characterised by low levels of value addition. This, according to the IPAP report, is in distinct contrast to the situation in a number of other developing countries where policies have been implemented that focus much more strongly on growing the production sectors. The results, for some of these countries, have been both a significant cushioning of the effects of the global economic crisis and the achievement – for example in Brazil - of some striking successes in ameliorating poverty and reducing inequality.

The report also says that South Africa, by contrast, has essentially been ‘treading water’. The medium-term outlook is for growth to improve gradually but for the recovery to be less robust than previously forecast. Real GDP growth is projected to recover to 2.7% in 2014 - from the estimated 1.8% in 2013 - and to reach 3.4% in 2015. Looking slightly further ahead – and in a continental perspective – SA’s real GDP growth is expected to remain well below the average of 5.4% projected for Sub-Saharan Africa in 2014–16.

If the South African economy is to overcome this lacklustre performance, we must begin to make a decisive break with the entrenched growth model – previously driven by increases in private credit extension and consumption - and move onto a more sustainable path underpinned by growth in the productive and employment creating sectors of the economy, according to the report.

The Real Effective Exchange Rate (REER), which is a measurement of the Rand’s performance against a basket of currencies, declined by 15.2% from March 2012 to September 2013. This, in principle, has the potential to give new impetus to price competitiveness, notwithstanding developments in other emerging markets.

Clearly, developing a stronger export-competitive dynamic cannot be a quick and straightforward matter, the report states. Value-added manufacturers have indeed not yet responded particularly strongly to the recent depreciation of the currency. This relative non-responsiveness – taken together with the large current account deficit – has been interpreted by many economic commentators as proof that SA manufacturing is fundamentally uncompetitive – without taking into account the debilitating impact of long periods of overvaluation followed by sudden sharp depreciations.

In this context, the relatively weak response to the recent depreciation is unsurprising. Manufacturing, according to IPAPI, is based on building up capabilities over considerable periods of time. Long periods of overvaluation and volatility have had a major cumulative effect on investment in equipment and capabilities, leading to a significant overall weakening of the industrial base. When inevitable ‘corrections’ occur, manufacturing does not respond like a tap that can be turned on and off at will. Manufacturers do not plan only for periods of depreciation; they know well from experience that any depreciation is likely to be followed in due course by periods of appreciation to which they will have to find carefully planned, long term competitive responses, the report says.

At present, therefore, the continuation of a ‘mixed’ pattern of responses to currency devaluation should be seen as a reflection of the ongoing struggle to adjust, re-tool and reinvest – in the light of a very challenging past five years of uncertainty and volatility compounded by severe external and domestic shocks as per IPAPI.

Meanwhile, South Africa’s ballooning current account deficit continues to expose serious macroeconomic vulnerabilities, especially given the role of short-term capital inflows in financing it. Since the advent of targeted IPAP interventions – over and above broader industrial support measures across sectors – a stabilisation in value addition in these sectors has been observed.

According to PAPI, despite the massive growth in credit extended to the private sector, only a tiny proportion has been extended to fixed capital investment: 5.6% in 2011 and 5.5% in 2012. South Africa’s relatively high real interest rates have started to compare more positively with those of our main peer competitors. For the first time in many years in 2012 our short term real interest rates were negative. The decline in the real cost of capital has the potential to start creating new impetus for expansion in the manufacturing sector. However, the decline in the real cost of capital may not be a panacea for the expansion of the manufacturing sector, if there is insufficient demand and wide-ranging competitiveness challenges are not addressed, the report says.

In 1994 the manufacturing sector made up 21% of GDP, steadily declining to 12.4% in 2012. Year-on-year manufacturing growth recovered tentatively during 2010 onwards. The volume of manufacturing production seasonally adjusted grew by 0.4% year-on-year in 2010, by 2.8% in 2011 and 1.4% during 2012. In 2013 the overall picture rem-ained uneven and unsteady.

PAPI indicates that on the employment front, however, the picture for manufacturing remains very disquieting. During the recession the economy shed around 1 million jobs with 200 000 jobs being lost in the manufacturing sector. Formal employment growth continues to come predominantly from the services sector, particularly wholesale and retail and the business services sub-sectors. In 2010, manufacturing employment briefly rebounded from its steep post-crisis downward path, but the recovery was short-lived and employment levels have steadily continued to fall. The decline in manufacturing employment levels can be attributed to a range of structural problems set out in IPAP.

Manufactured goods constituted 51.6% of the merchandise export basket in 2012, up from 41.2% in 1994. A few sectors are the main contributors to this trend: machinery and equipment, motor vehicles (including components for auto assembly), refined petroleum products and other chemicals. Manufacturing exports are highly concentrated, with the top 20 manufacturing sub-sectors (out of 120) accounting for 77% of SA’s manufacturing export basket in 2012 and – even more strikingly – the top 5% of South African export companies accounting for more than 90% of total exports.

According to Pietman Roos, policy consultant with the South African Chamber of Commerce and Industry, it would be far better if the DTI focused its resources on two or three key industries with the biggest job-creation potential. The sheer scope of IPAP suggests that it is usurping the role of fiscal policy.

“The argument that the business environment makes South Africa’s manufacturers internationally uncompetitive and therefore requires government support by way of industrial policy is misplaced. Improving the business climate is not the role of industrial policy but of macroeconomic policy. The motivation behind expansive industrial policy in South Africa is a combination of avoiding policy prioritisation and an archaic view about the role of the state in the economy. The old joke in civil society is that South Africa has become the expert in drawing up strategy documents — but this phenomenon has intensified. South Africa now boasts the National Development Plan (NDP), the New Growth Path and IPAP. Despite some differences in style, each document is similar in the way in which it seeks to cover every conceivable policy avenue without prioritising these policies. These policies are often mutually exclusive.

“Government intervention in the economy implies that the private sector is somehow not capitalising on opportunities. The NDP uses the language of ‘directing’ industry to exploit niche opportunities. The obvious critique of such a view is that business has already exploited all possible sources of revenue and that once-dormant industries will ultimately fail as soon as government support is withdrawn. Ipap is more aggressive as there is no sunset clause,” says Roos.